Flight Not Over

Keep your seat belt fastened and refrain from moving about the cabin. The aircraft has most definitely not reached the terminal. After a July filled with doomsday predictions, the world breathed a sigh of relief when president Barack Obama took to the airwaves on a Sunday evening to announce that a deal had been reached to raise the US government’s debt ceiling and a crisis had been averted. The world’s largest economy would not default on its obligations and would seemingly avoid a downgrade of its credit rating. Interest rates would not rise sharply, equity markets would stabilize and no one else would have to resort to panning for gold on the Nova Scotia coast.

Insurers watched the high stakes poker game in Washington with great interest. As one of the largest purchasers of (supposedly safe) government bonds, the insurance industry is a de facto lender of choice for the US and other governments. In a July 19 briefing, ratings company A.M. Best warned that P&C companies that have “large exposure to declines in the market value of bonds due to an increase in interest rates, and that also may need to realize the loss due to liquidity needs, could have ratings affected.”

Somewhat overlooked in discussions about insurers’ investment exposures was the equity markets. In a survey of 35 US insurers by Towers Watson in late July, senior executives ranked a lack of market liquidity and stock market volatility as their leading concerns behind a possible decline in capital if the US Congress failed to reach an agreement. Ultimately, however, equity investors were unimpressed by the compromise over the US debt ceiling and only four days after the deal was announced, the Dow Jones industrial average and the TSX both took a vertiginous tumble, each losing over 3% of their value in a single day—the crescendo of an 11% decline over two weeks—on investor concerns about economic indicators pointing to a double-dip recession.

It all adds up to a challenging environment for insurers. A slowdown in manufacturing and falling commodity prices will weaken demand for insurance products and put downward pressure on pricing at a time when capacity has been strained by unusually high catastrophe losses and investment returns are weak. Now more than ever, strong underwriting fundamentals have never been more important to getting through a bit of turbulence.